Tax burden of a founder resident in Germany

The assets invested at the time of the establishment of a Liechtenstein private-benefit foundation (family foundation/corporate foundation) by a founder resident in Germany may result in German income tax, VAT and inheritance tax/gift tax charges for the founder.
The founder does not receive a special expense or donation deduction for the donation of assets in Germany.

German income tax

If the founder transfers individual assets from his private assets to the Liechtenstein private-benefit foundation, this is deemed a private transaction and is generally not subject to income tax for the founder. As the founder transfers his assets free of charge, this does not constitute a taxable sale transaction.

The transfer of individual assets from the business assets, on the other hand, leads to a taxable current withdrawal of profit in the amount of the difference between the book value and the going concern value.

German inheritance and gift tax

The assets of the Liechtenstein private-benefit foundation in the case of establishment mortis causa and inter vivos are subject to inheritance and gift tax.

The founder of a Liechtenstein private-benefit foundation domiciled in Germany benefits in Germany from the special inheritance tax benefits of the tax class privilege and the exemption rules for favoured business assets, provided that

1. the foundation freely disposes of the assets under civil law,
2. the founder does not have comprehensive powers of control over the foundation’s assets,
3. the Liechtenstein private-benefit foundation is not transparent and is structured like a German family foundation, i.e. according to its articles of association, the founder, his relatives and their descendants are entitled to more than half of the benefits or accruals.

Tax debtor: The Liechtenstein Foundation is the tax debtor in the case of acquisition mortis causa. In the case of gifts inter vivos, the foundation and the founder are jointly and severally liable.

Asset valuation: The valuation is based on the German Valuation Act. Business assets (e.g. sole proprietorships and participations of co-entrepreneurs in partnerships), real estate, shares in corporations or agricultural and forestry businesses are valued at their fair market value. There is a special valuation discount of 10 per cent for properties that are rented out for residential purposes.

Gift tax class privilege: In Germany, the free-of-charge transfer of assets to a non-charitable foundation falls into the unfavourable German tax class III, as the foundation, as a legal entity, cannot be related to the founder. The tax rates in tax class III are 30 to 50 per cent.

However, the family foundation has a special position: In the case of a German family foundation, the relationship between the most remote beneficiary according to the foundation deed and the testator or donor is used as the basis for determining the tax class when the assets are invested at the time of establishment. This also includes a person who is not yet a direct beneficiary at the time the foundation is established, but only becomes a beneficiary in the succession of generations.
If, for example, the spouse, partner, children, stepchildren, descendants of children, great-grandchildren and other descendants are the most distant beneficiaries, the favourable German tax class I is applied.
The gift tax class privilege affects both the determination of the tax rate and the application of the personal allowance and also benefits the German founder when transferring assets to a private-benefit Liechtenstein foundation.
Subsequent foundations also benefit from the gift tax class privilege, provided that the possibility of a subsequent foundation is provided for in the articles of association.

Tax relief regulations for favoured business assets

The German Inheritance Tax Act / Gift Tax Act provides for exemption regulations for favoured business assets. These regulations also apply to founders resident in Germany when transferring assets to a Liechtenstein private-benefit foundation.
These essentially include

• domestic agricultural and forestry assets and corresponding agricultural and forestry assets serving a permanent establishment in the European Union or the European Economic Area;
• domestic business assets, in particular commercial enterprises, business units and co-entrepreneur shares and corresponding business assets that serve a permanent establishment in the EU or the European Economic Area;
• shares in corporations domiciled in the EU or the European Economic Area, if there is a participation of more than 25 per cent.

A person who acquires favoured business assets is granted two models. In the case of standard relief (without application), a relief discount of 85 per cent is initially granted:

• The inheritance or gift tax on 85 per cent of the favoured business assets is initially deferred and waived pro rata for each year in the event of the continuation of the business as a going concern within the meaning of the Inheritance Tax Act.
• The business continue for at least five years.
• During these five years, the total wages must reach at least 400 per cent of the average total wages of the last five years before the transfer of the business.
• Assets under management may not account for more than 50 per cent of the business value.

Under the exemption option, the family foundation is initially granted a 100 per cent exemption from inheritance tax upon application under certain conditions. The inheritance or gift tax is initially deferred and, if the business is successfully continued, is waived pro rata for each year and in full after seven years. The conditions:

• The total wages during the seven-year period must amount to 700 per cent of the average wages of the last five years before the valuation date.
• Assets under management may not exceed 10 per cent of the business value.

Assets under management essentially include

• Land ceded to third parties for use;
• Shares in corporations if the direct participation in the nominal capital of these companies is 25 per cent or less;
• Participations in partnerships and shares in corporations if the assets under management of these companies amount to more than 50 per cent;
• Securities and comparable receivables that do not serve the main purpose of operating a bank or insurance company;
• Works of art, art collections, scientific collections, libraries and archives, coins, precious metals and precious stones that do not serve the main purpose of the business or the company.

If the retention periods or the total wages are not adhered to, the relief deduction is reduced. Among other things, the sale, discontinuation or partial sale of a business,

the sale or withdrawal of significant business assets, excess withdrawals and the sale of shares in corporations are considered detrimental.

VAT: If the founder provides the private-benefit Liechtenstein foundation with cash assets, this does not trigger VAT. The (free-of-charge) transfer of a business or part of a business to a private-benefit Liechtenstein foundation constitutes a non-taxable sale of the business as a whole.
If individual assets are removed from the business assets and transferred to the foundation, this constitutes a free-of-charge transfer of value subject to VAT.

Real estate transfer tax: The free-of-charge transfer of a property to a Liechtenstein private-benefit foundation does not trigger real estate transfer tax.

Exit tax (external tax recognition of hidden reserves)

If a founder resident in Germany dedicates significant participations in a German corporation to a Liechtenstein private-benefit foundation, such a measure leads to the realisation of the hidden reserves contained in the dedicated participations in the course of „exit taxation“ and triggers income tax consequences.

Dedications of participations in partnerships are generally income tax-neutral, as there is no realisation of hidden reserves.

A transfer of real estate assets is also not recognised under foreign tax law in Germany, as the current income from letting and leasing and sales transactions remains recognised in Germany after the transfer due to the limited income or corporation tax liability of the Liechtenstein foundation.

German tax law also does not recognise hidden reserves when liquid assets are allocated.

Interest payments on donor loans

In addition to donations subject to gift tax, the founder can also grant loans to the foundation to finance it.
At founder level, the interest is income from capital assets and must be declared and taxed at 25% in Germany.
Liechtenstein does not retain any withholding tax on interest paid.

Foundation’s income added to the founder’s income for income tax purposes in Germany

1. Trust-like foundation structure

The foundation’s income is added to the founder’s income for income tax purposes,

• if the founder has reserved such extensive rights within the framework of the foundation transaction that he can subsequently exclude the foundation and its bodies from exercising any economic influence on the foundation’s assets,
• in the case of unrestricted reservations of cancellation rights of the foundation transaction or comprehensively reserved amendment rights of the founder,
• in the case of foundation structures by means of mandate agreements between the founder and the administrative body (trustee) that are bound by instructions.

1. Institutional control of the managing body of the foundation by the founder and his relatives

If the majority of the beneficiaries of a Liechtenstein foundation are family members of the founder, it is the responsibility of the founder and his relatives to prove that the beneficiaries have no rights of influence over the foundation.

Failure to do so may result in an income tax addition for the founder.